Retirement tax planning should be a time that is stress free, especially when it comes to your finances. However, it is not unusual for new and seasoned retirees to be unpleasantly surprised by hefty taxes. Retirement taxes can impact their set income from social security, retirement accounts, savings, freelance income, and other modest sources.
These obstacles can often be avoided with smart financial planning. The benefits of retirement planning are lifelong, and the financial experts at Waters Hardy can assist with financial planning in all life stages, including before, during, and after retirement.
In the meantime, however, there are a few fundamentals that every soon-to-be or current retiree should know about Social Security and taxes. If you are on the edge of retirement, keep the following FAQs in mind to ensure a happy and healthy financial situation for the indefinite future.
How Are Social Security Retirement Benefits Taxed?
Under federal law, Social Security benefits are taxed for individuals with a combined income of at least $25,000 per year. And for married couples with a combined income of at least $32,000 per year.
Generally speaking, if Social Security is your only source of income during retirement, then you likely will not be taxed. The reason is that the average amounts are below the $25,000 or $32,000 thresholds. Even with a recent 5.9% cost of living increase in January of 2022, the average Social Security check to a retiree beneficiary was $1,656.30 in 2022, which equals an annual income of $19,875.60.
Do I Have to Pay Taxes on Retirement Income?
If your combined income is above $25,000 (or $32,000 if you are married and filing jointly), then your income will indeed be taxed.
For combined incomes of $25,000 to $34,000 (single) or $32,000 to $44,000 (couple), up to 50% of what you receive from Social Security is taxable.
For combined incomes that are $34,000 (single) or $44,000 (couple), up to 85% of your Social Security benefits are taxable.
How Can I Reduce My Taxes on Social Security and Retirement Income?
You can embrace several strategies before and during your retirement to minimize the taxes you will have to pay as a retiree.
Let’s explore the following strategies for retirement tax planning.
Convert to a Roth IRA
Any withdrawals on a Roth IRA or a Roth 401(k) are not subject to taxes in retirement because taxes were already paid when the contributions were made. This is not the case with traditional IRAs or 401(k)s since you received a tax advantage in the form of an income tax deduction when you contributed to these accounts earlier in life.
As such, a Roth account is a smart move for future retirees concerned about future taxes. Therefore, any withdrawals made from these accounts will not go toward the combined income total on your annual taxes.
However, it’s important that you must have your Roth account open for at least five years and be over the age of 59.5 to receive these tax-free benefits. Also, if you convert an existing retirement account to a Roth IRA, you will likely owe income tax on that conversion.
Consider Different Types of Investments
Not all investments are considered equal when it comes to taxes. Furthermore, most bonds, savings accounts, and traditional retirement accounts are subject to taxes. However, some investments are not, including and especially municipal bonds. Municipal bonds are generally exempt from federal and state income taxes, with a few exceptions.
Delay Your Social Security Benefits
If you have multiple forms of income once you reach retirement, from savings accounts, 401(k), or even side jobs or freelance opportunities, consider postponing your Social Security benefits. You’ll receive heftier benefits the longer you wait, with an average increase of 8% per year until you turn 70. If you rely on your other financial assets until then, chances are that fewer outside accounts and assets will affect your combined income once you start receiving Social Security benefits.
Minimize Withdraws from Your Retirement Plan and Do It Strategically
Any funds that you withdraw from your traditional IRA or traditional 401(k) will count as taxable income in the year that you proceed with a withdrawal. Therefore, it will increase your overall adjusted gross income, which will make you subject to the tax rates above.
So, with these combined income amounts in mind, ensure that any funds you withdraw are strategically planned, year by year. Note that you will likely need to take a required minimum distribution annually. However, an adept financial planner can help you strategize the best withdrawal plan to minimize your overall taxes in retirement.
Donate Your Required Minimum Distribution
Suppose your minimum distribution puts your combined income at a taxable level. In that case, you can also donate your withdrawals, which could allow you to deduct the amount from your adjusted gross income. Keep in mind there are some parameters that may affect your donations. To be eligible for the qualified charitable distribution rule, you’ll need to be over the age of 72. Additionally, you need to pay the distribution directly from the IRA to the charity. In addition, the total amount donated cannot be over $100,000 a year.
Start Your Retirement Tax Planning Now for the Biggest Benefits in the Years Ahead
Your smartest move when it comes to minimizing your taxes in retirement is to partner with the experienced team at Waters Hardy. Since 1981, we have been providing accounting services and tax optimization for individuals and businesses alike at every stage of life, and we honor exceptional results.
When it comes to retirement tax planning, there are numerous factors, obstacles, and financial moves to ensure that you have a solid income to rely on for decades to come, and it’s essential to be prepared.
Regardless of if you have just started to plan for retirement or are just starting to enjoy your new post-work world, we can help.
Let’s work together to come up with a strategy that will ensure the hard-earned income that you acquired over the course of a lifetime remains in your pocket.